Part 1: Regulation needed (May 16, '05)
Part 2: 'Cool' not a good thing in Beijing (May 17, '05)

CHINA PROPERTY BEAT
PART 3: Foreign money floods Shanghai

BEIJING - Nothing is subtle about Hong Kong town in Shanghai.

Dominating the center of Huai Hai Middle Road, one of the city's prime business areas, are the twin towers of Hong Kong Plaza, linked by a footbridge that spans the wide boulevard. On its right and left, extending for three to four city blocks, are skyscrapers bearing names that are unmistakably Hong Kong - Lippo Center, Central Plaza, New World Plaza, Shui On Plaza and Shanghai Times Square. They are all owned by Hong Kong's major property developers.

On the other side of Huai Hai Park is Xintiandi, a cluster of bars combining Shanghai architecture with modern decor, developed by Hong Kong's Shui On Land. On the adjacent blocks are properties, including a service apartment complex and several office buildings, developed by Singapore investors, mainly CapitaLand. "Shanghai's commercial real estate market is an emerging investment magnet for overseas property developers," says Wayne Zane, associate director of Colliers International Property Services (Shanghai). "Demand for prime office space has continued to outstrip supply by a widening margin."

Much of the demand is fueled by the influx of foreign companies to Shanghai, increasingly the location of choice for doing business in China. In addition, many established foreign companies in Shanghai are expanding their operations to take advantage of the opportunities arising from the rapid opening of various sectors of the Chinese market in accordance with China's entry into the World Trade Organization .

Property developers and agents are expecting the demand for not only prime office premises, but also hotels, serviced apartments and retail space, to increase at a progressively faster rate leading up to the World Expo in Shanghai in 2010. So far, the majority of overseas investment into the Shanghai office market has come from Hong Kong and, to a lesser extent, Singapore. But the potential of that market has not gone unnoticed by the global property investment funds, some of which are managed by the biggest names in international finance. "In the past few months the market, which includes office, service apartments and hotels, has also attracted great interest from international institutions, who have started pouring millions of dollars into Shanghai," Zane says.

In February, Macquarie Global Property Advisor, a member of the Australian-based Macquarie Bank Group, completed the purchase of the entire Xin Mao Tower near Xintiandi from Singapore-based real estate developer CapitaLand for US$98 million. The 20-story tower, due to be completed in 2006, has an above-ground gross floor area of 32,200 square meters. In April, Goldman Sachs made its first big investment in Chinese property. It paid $107.6 million to CapitaLand for the 24-storey Pidemco Tower in Shanghai's Huangpu District. The commercial and office building has an above-ground gross floor area of 41,661 square meters. This latest transaction is the largest sale of a complete building in Shanghai's Grade-A office market, which indicates investors' confidence in the city's commercial market and its overall economic prospects, says Zane.

"Previously, Macquarie invested exclusively on the residential side but now it is expanding its portfolio to the commercial market, as it is less risky and has more solid fundamentals than the residential sector," says Reed Hatcher, senior research manager of Debenham Tie Leung (DTZ), a leading Hong Kong-based property consultancy firm. "We expect similar transactions in the future because we are seeing enormous demand in the commercial market, in particular for the Grade-A office properties that target multinational tenants."

Zane from Colliers agrees that foreign investors are more cautious on the residential sector, which is already overpriced, but they are more bullish on the office side. "The office market in Shanghai is just starting to grow and has a long way to go before reaching the peak," he says. According to Colliers, the average office rent rose about 17% to $0.81 per square meter in the first quarter of this year, while the average vacancy rate edged down to 6.7% during the period due to the keen demand for prime office buildings.

Unlike the hot money that has been gushing into the residential market, the investment in office premises is largely managed by corporations or institutions which take a long-term view. "They are not looking for short-term gain," says Zane. "The demand is driven by both investors expanding the business and those making new investments in China, a market too dynamic to be ignored." Furthermore, foreign investors' confidence in the stability and the strength of the yuan, which can effectively minimize foreign exchange risks, also underpins the investment whirl, Zane adds.

Shanghai's economy has achieved double-digit growth for 13 straigh years. In 2004, its gross domestic product climbed 13.6% to approximately $90 billion and the foreign direct investment grew 12.6% from last year to $11.7 billion. In 2005, growth of foreign investment is expected to increase further to $12 billion. The city, the regional headquarters for at least 88 multinational companies, is spending heavily on infrastructure in preparation for the World Expo, an event that could catapult Shanghai to the forefront of international financial centers.

DTZ's Hatcher says a great number of foreign companies that have already established a presence in China are now moving their China headquarters to Shanghai, or enhancing their presence there, which provides a solid client base for the office market. For instance, the international banking sector is looking ahead to 2007 when they could have full access to the local market, Hatcher says. Right now, many foreign banks are expanding their offices. In the past, the average size of a foreign bank's office in Shanghai was between 3,000 and 5,000 square meters. Now it has jumped to 15,000-20,000 square meters, says Hatcher.

Colliers' latest research on the city's office market shows that capital values of prime office buildings increased 3.5% quarter to quarter to an average of $3,260 per square meter during the first three months in 2005. Office investment yields edged down from 7.7% in late 2004 to 7.5% during the first quarter this year. Reflecting the sustained investment demand, Colliers forecast capital values to rise 7% and investment yields to fall to 7.3% over the next 12 months.

On the other hand, tight supply and strong demand, as well as rising rent in the grade-A office market has prompted many companies to take a long-term view of their office expansion strategy, DTZ's Hatcher says. DTZ, the leading property consultant in Shanghai's real estate market, estimated that new supply in the city's grade-A office market would grow to 545,900 square meters in 2005, an increase of 57% over a year earlier. The annual uptake this year is projected to 500,000 square meters, a similar level to 2004. It also expects the rental growth to be 10-15% this year and a further 5-10% in 2006, with the vacancy rate below 7%.

As Hatcher points out, previously companies would expand the size of their offices by 500 square meters a year, but now "the limited availability of space in top-tier offices" is threatening to hinder their future expansion. So some multinationals are looking for offices in downtown areas and some in fringe areas that will allow them to have greater flexibility in the coming years.

Meanwhile, the robust office market also allows property developers to prepare more diverse marketing strategies. Just two to three years ago, office developers did not have any pre-lease activities, usually leasing offices only when the buildings were fully completed because it was fairly easy to find office space then. Now it is almost impossible to find 2-3 floors of space in prime office areas on the Puxi side, such as Nanjing West Road and People's Square, which record near-100% occupancy rates. As a result, developers are beginning pre-lease campaigns and now lease offices 6-12 months before the properties are completed, Hatcher says. "Before, companies could enjoy significant concessions, like big rental discounts from landlords, if they leased and moved into the office building early. Now only negligible discounts are available for the very early birds."

From the perspective of property developers, both Zane and Hatcher agree, it is more reasonable for developers to diversify their investment portfolios and shift to a potentially huge sector like offices and service apartments. "We are still looking for new investment opportunities, including new development projects and income-generating properties in major cities like Beijing and Shanghai," Lim Ming Yan, chief executive officer of CapitaLand China, said in a written reply to China Daily. After selling the Xin Mao Tower for $98 million in February, the company bought two office buildings in Beijing for nearly 2 billion yuan ($241 million) in March, and plans to revamp them and turn them into prime offices.

Tomorrow: Part 4 - Hong Kong hypes dubious flats; mainland buyers undeterred

(Asia Pulse/XIC)